Question

Come-Clean Corporation produces a variety of cleaning compounds and solutions for both industrial and household use. While most of its products are processed independently, a few are related, such as the company’s Grit 337 and its Sparkle silver polish. Grit 337 is a coarse cleaning powder with many industrial uses. It costs $1.60 a pound to make, and it has a selling price of $7.00 a pound. A small portion of the annual production of Grit 337 is retained in the factory for further processing. It is combined with several other ingredients to form a paste that is marketed as Sparkle silver polish. The silver polish sells for $5.00 per jar. This further processing requires one-fourth pound of Grit 337 per jar of silver polish. The additional direct variable costs involved in the processing of a jar of silver polish are: Other ingredients $ 0.50 Direct labor 1.36 Total direct cost $ 1.86 Overhead costs associated with processing the silver polish are: Variable manufacturing overhead cost 25 % of direct labor cost Fixed manufacturing overhead cost (per month) Production supervisor $ 3,200 Depreciation of mixing equipment $ 1,500 The production supervisor has no duties other than to oversee production of the silver polish. The mixing equipment is special-purpose equipment acquired specifically to produce the silver polish. It can produce up to 4,500 jars of polish per month. Its resale value is negligible and it does not wear out through use. Advertising costs for the silver polish total $4,800 per month. Variable selling costs associated with the silver polish are 5% of sales. Due to a recent decline in the demand for silver polish, the company is wondering whether its continued production is advisable. The sales manager feels that it would be more profitable to sell all of the Grit 337 as a cleaning powder. Required: 1. How much incremental revenue does the company earn per jar of polish by further processing Grit 337 rather than selling it as a cleaning powder? (Round your answer to 2 decimal places.) 2. How much incremental contribution margin does the company earn per jar of polish by further processing Grit 337 rather than selling it as a cleaning powder? (Round your intermediate calculations and final answer to 2 decimal places.) 3. How many jars of silver polish must be sold each month to exactly offset the avoidable fixed costs incurred to produce and sell the polish? (Round your intermediate calculations to 2 decimal places.) 4. If the company sells 7,500 jars of polish, what is the financial advantage (disadvantage) of choosing to further process Grit 337 rather than selling is as a cleaning powder? (Enter any "disadvantages" as a negative value. Round your intermediate calculations to 2 decimal places.) 5. If the company sells 10,400 jars of polish, what is the financial advantage (disadvantage) of choosing to further process Grit 337 rather than selling is as a cleaning powder? (Enter any "disadvantages" as a negative value. Round your intermediate calculations to 2 decimal places.)

Answer 1

Requirement 1 :

Incremental revenue from further processing = $ 5.00 - $ 7.00 x 1/4 = $ 3.25 per jar of silver polish.

Requirement 2 :

Incremental contribution margin = Incremental revenue - Increment variable costs

Incremental variable costs = $ 0.50 + $ 1.36 + $ 1.36 x 25 % + $ 5 x 5% = $ 2.45

Incremental contribution margin = $ 3.25 - $ 2.45 = $ 0.80 per jar of silver polish

Requirement 3:

Number of jars to sold each month to offset the avoidable fixed cost = . ( Salary of production supervisor + Advertising costs) / Incremental contribution margin per unit = $ ( 3,200 + 4,800) / $ 0.80 = 10,000 jars.

Depreciation of mixing equipment is an allocation of a sunk cost, and hence is not relevant.

Requirement 4 :

Financial advantage ( disadvantge) of selling 7,500 jars of silver polish = Contribution margin - Avoidable Fixed cost = 7,500 x $ 0.80 - $ 8,000 = - $ 2,000

Requirement 5:

Financial advantage ( disadvantage) of selling 10,400 jars of silver polish = 10,400 x $ 0.80 - $ 8,000 = $ 320.